What are the various types of preference shares?

Authored by
Team Espresso
May 29 2023
5 min read

Preference shares, also called preferred stocks, are a class of shares that provide holders with additional privileges over ordinary shareholders. These privileges include receiving monthly dividends before common shareholders and receiving firm assets before common stockholders in the event of bankruptcy. However, these benefits are exchanged for the inability to vote on the company’s business decisions. 


What are preference shares? 


Preference shares are bought by investors who want to earn passive income and are largely unconcerned with the decisions taken by the upper management. A company may choose to issue preference shares for a variety of reasons.


Among them is to avoid hostile takeovers. Companies may choose to issue preference shares when they want to protect themselves from a hostile takeover, as preference shares do not have any voting rights.


As a side note - A hostile takeover refers to a scenario when the acquirer gains control of a company whose management is unwilling to agree to a merger or takeover.


Types of preference shares 


There are several types of preference shares. Some of them are as follows: 


Redeemable preference shares 


Companies issue redeemable preference shares when they need financing for specific initiatives but do not want to take out loans or dilute the stock. Such shares can be redeemed by the company at a later date.  The companies announce a date at which they will redeem the shares beforehand. Depending on market conditions, the redemption price may or may not be publicized in advance. Usually, repurchase prices are higher than the price of issuing the shares.


Irredeemable preference shares 


As the name implies, such shares cannot be redeemed by the firm, and are treated the same as ordinary shares. Irredeemable preference shares are valid until perpetuity or until the company winds up its operations. 


Cumulative preference shares


Cumulative preference shares allow shareholders to receive dividend payouts even when the company is not profitable. When a corporation is running in losses, it saves the promised dividends and pays them to the shareholders when it turns a profit. For instance, assume that Sucheta Textile has issued cumulative preference shares at Rs 100 per share, with a promise to pay a 5 percent dividend every year, amounting to Rs 5 per share. Now, consider that economic conditions are grim and exports slow down. In such a case, Sucheta Textile could not pay dividends for two years because of unforeseen losses. However, the company’s financial health eventually improves and it returns to profits in the third year. Thus, Sucheta Textile will now pay a dividend for three years, that is, Rs 15 per share, to holders of cumulative preference shares.


Non-cumulative preference shares 


Non-cumulative preference shares, on the other hand, do not accumulate any unpaid dividends. Dividends are paid on these shares solely from profits in the current fiscal year. As a result, dividends will not be paid to non-cumulative preference shareholders in years when the company loses money.


Convertible preference shares 


Convertible preference shares come with an option to be converted into ordinary shares of a company when the pre-set maturity period ends. For example, suppose Sucheta Textile issues convertible shares with a promise to pay Rs 5 per share at Rs 100, along with the option to convert them into equity 10 years later. After the 10-year period is over, an investor would not just have received Rs 50 in dividends for the past 10 years, but they will also be able to convert their holdings into ordinary shares and sell them on the secondary market.


Non-convertible preference shares 


Non-convertible preference shares do not have the option to be convertible into common stock. Holders of such shares simply benefit from the preferential treatment afforded to holders of regular preference shares.


Adjustable-rate preference shares 


These preference shares pay dividends at a floating rate, depending on market conditions and the financial health of the issuing company. Thus, there is no surety on how much dividend an investor who holds adjustable-rate preference shares will receive.


Participating preference shares 


Participating preference shares have clauses that allow holders to receive extra dividends if the company delivers extra profits. For example, imagine if Sucheta Textiles issues participating preference shares at Rs 100 with a promise of a 5 percent dividend every year, along with an extra 5 percent if the profit growth is more than 60 percent. Thus, in years when Sucheta Textiles’ profit jumps more than 60 percent, the holders of participating preference shares will get Rs 10 per share in dividends. Participating preference shares may also have clauses that deliver extra benefits to holders at the time of liquidation of assets, or give voting rights regarding the sale of company assets. 




Why do companies issue preference shares? 


The reason behind issuing preference shares is mostly to raise capital by promising preferential treatment to prospective investors. Sometimes, the reason can also be to invite an influential investor who may bring more investors to the company.


How are preference shares different from ordinary shares? 


Ordinary shares have voting rights while preference shares usually do not have voting rights regarding most of the company’s proposals at general meetings. However, preference shareholders get first preference on dividends and a stake in company assets at the time of liquidation.  


How do I buy preferred shares? 


Sometimes, companies may come out with preference share issues even for retail investors. You can wait for such occasions and buy preference shares at that time.

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